Tuesday, 8 March 2011

The latest Moody’s Downgrade of Greece

Moody’s today downgraded Greece to B1 from Ba1, with a negative outlook on the rating. There were three main reasons expressed by the agency for this (original text available at www.moodys.com; free registration required):

1.The fiscal consolidation measures and structural reforms that are needed to stabilise the country's debt metrics remain very ambitious and are subject to significant implementation risks, despite the progress that has been made to date.

2.The country continues to face considerable difficulties with revenue collection.

3.There is a risk that conditions attached to continuing support from official sources after 2013 will reflect solvency criteria that the country may not satisfy, and result in a restructuring of existing debt. Moreover, the risk of a post-2013 restructuring might lead the Greek authorities and investors to participate in a voluntary distressed exchange before that time.

Each of these three reasons are fair and in line with every other serious, objective analysis of Greece’s reform effort. The third point is particularly interesting: absent a radical recovery in the Greek economy, an improvement in revenue, or a restructuring of loan terms, the government itself admits that debt payments in 2014-2015 will be difficult to achieve.

Given the German insistence that any future successor to the European Financial Stability Facility (EFSF) include a specific condition that the costs of future bail-outs to be partially borne by private creditors, Moody’s point is quite accurate. While this is no doubt fair from the political (and taxpayer) viewpoint, observers everywhere have pointed out that one cost of this will be an increase in bond yields as private sector creditors adjust their risk frameworks. It is ironic that George Papandreou initially agreed with this assessment.

The threat of this future haircut is exactly what Moody’s is pointing out: that a post-2013 restructuring of the EFSF will likely impose haircuts on private creditors. From a credit rating viewpoint, therefore, this has to be factored into the risk weighting.

The government’s response was immediate and scathing. The Ministry of Finance issued a press release which accuses Moody’s of everything from apparent incompetence to sinister ulterior motives. The following paragraph (my translation from Greek) is indicative:

In the final analysis, today’s downgrade by Moody’s is more revealing of the wrong motives and lack of accountability of the rating agencies than for the real situation of the Greek economy. These agencies have not identified in time the increase in financial sector risks which lead to the financial crisis of 2008, and now compete among themselves to be first in the “discovery” of risks which will lead to the next crisis. In a particularly sensitive time for the global economy and markets, similarly unjustified ratings decisions contain the danger that they will lead to self-fulfilling prophesies. It is certain that this approach makes it necessary to have more effective regulation of the ratings agencies on a European and international basis. (Greek original text at end of post)

Yet it is hard to see what ulterior motives Moody’s may have. The facts speak for themselves: Greece did not meet its revenue targets in 2010; the debt proved to be far higher than what was announced even in March 2010 leading to a multi-year restatement in October 2010; serious structural reforms have not yet taken place; Greece’s GDP fell by at least 4.5% in 2010.

Today, Greece owes over EUR 340 billion in sovereign debt. If we take the 2009 GDP figure of EUR 236.63 bln of accurate, and estimate that 2010 GDP shrank by -4.5%, then 2010 GDP was EUR 225.98 bln. Greece’s debt-to-GDP ratio is therefore already 150.5%. With interest rates widely expected to rise based on the Jean-Claude Trichet’s latest comment on “strong vigilance” and given clear evidence of higher inflation, financing this debt will become increasingly difficult and expensive, even if a creditor haircut were not foreseen.

Most financial sector participants have already factored in a Greek default or haircut as part of a debt restructuring: most estimates are between 30-40%. The European Central Bank itself, while continuing to accept Greek government bonds as loan collateral, applies a 13.5% discount.

Together with Greece’s vitriolic response against the Troika’s press conference on the EUR 50 bln privatisation plan in February, it is difficult to see what the Greek government gains by such public attacks. The responsibility for implementing the debt-workout and public reform programme is that of Greece and Greece alone. Attacks on ratings agencies for stating the obvious does nothing to help the situation, except perhaps for domestic political reasons.

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